Done Right, A Debt Agreement Could Still Yield Positives: Echoes

The debt-limit battle of 10 years ago still echoes, but a new ring of accomplishment can also be heard.

I was Treasury Undersecretary in 2001 when the recession and the impact of the Sept. 11 terrorist attacks required the first debt-limit hike in four years. Treasury made the request to Congress in early December, and, unsurprisingly, Congress tabled it at first. A vote to raise the debt ceiling has never been popular.

So Treasury staff deployed the same accounting maneuvers they’re using today, and they kept the debt below the ceiling for as long as possible, waiting for Congress to act. For example, they stopped reinvesting federal pension-fund earnings in Treasury securities, promising to make up the difference later. Eventually, Congress did act, but with a six-month delay: On June 27, 2002 the House passed a $450 billion debt-limit increase by a one-vote margin and President George W. Bush signed the bill into law the next day. That one-vote margin makes the eight-vote margin achieved by House Speaker John Boehner on Friday look like a romp.

Now, with the Treasury’s Aug. 2 deadline nearly here and only a vague outline of a deal emerging, some ask whether other accounting tricks are available to push the deadline back. Judging from past experience, they certainly are available, but none are very attractive. For example, as Alex Pollok and Anne Canfield of the American Enterprise Institute write, the Treasury could deposit gold certificates at the Federal Reserve in exchange for cash deposits that could then be used to make payments, as occurred in 1953. But this would bring the Fed into the middle of a contentious fiscal-policy debate and invite further questions about its independence at a time of wide-spread criticism of its recent quantitative easing and bailout operations. Better to settle the issue now and keep the Fed out of fiscal policy.

In fact, now that the Boehner plan and the Reid plan have been presented, scored by the Congressional Budget Office and voted on, the time is ripe for a good agreement that can pass the House and Senate and be signed by the president.

The Boehner plan and the Reid plan have two important similarities that bode well for a quick agreement. First, they both adhere to the principle that spending-growth reductions should equal the amount by which the debt limit is increased -- a principle that is new to the debt-limit debate this year and is highly welcome. Second, they both exclude tax increases. So the final agreement should include these two principles.

But an important difference needs to be resolved. The Reid plan increases the debt limit in one step by about $2.5 trillion, which takes us beyond the 2012 elections. (Note that I am rounding to the nearest half or whole trillion in using these figures, which remain unsettled.) The Boehner plan -- about the same overall size as the Reid plan -- has a two-step increase, starting with about $1 trillion now and adding another $1.5 trillion in early 2012 if certain criteria or triggers are satisfied.

The issue is not merely election-year politics. The higher spending reductions needed to match the higher initial debt-limit increase in the Reid plan rely on questionable accounting assumptions: The reductions include scaling back of operations in Iraq and Afghanistan, which is expected to occur anyway. The Republicans call this a “gimmick,” and they won’t accept it. So the only way to get a $2.5 trillion debt-ceiling hike now would be for the Democrats agree to convert this “gimmick” into real spending reductions. I see this as unlikely right now.

This means the two-step approach looks like the only workable solution. But to make the approach more acceptable to Senate Democrats and to President Barack Obama, the criteria or triggers for the second tranche must be easier to satisfy, and thereby more likely to occur without another major battle. One trigger for the second tranche now in the Boehner bill is that the Senate and House pass a balanced-budget amendment. The Democrats won’t accept that, but it could be replaced with an alternative trigger that appeals to both Democrats and Republicans. A simple one is that the second tranche must be accompanied by real spending reductions of an equal magnitude to be worked out later this year.

Such an agreement would eventually increase the debt limit by $2.5 trillion, but also reduce spending growth by the same amount -- a really positive outcome especially compared with the minimal accomplishment of the debt-limit battle a decade ago, or most other debt-limit battles for that matter.

Much would be left to do to put the American fiscal house in order. As explained in my recent Echoes post, another $3.5 trillion in savings on top of the $2.5 trillion is needed to fill the budget gap. But that additional amount can be a subject of debate in next year’s election campaign.

(John B. Taylor, a contributor to the Echoes blog, is the Mary and Robert Raymond Professor of Economics at Stanford University and the George P. Shultz Senior Fellow in Economics at the Hoover Institution.)

To contact the author of this blog post: http://johnbtaylorsblog.blogspot.com.

To contact the editor responsible for this blog post: Timothy Lavin at tlavin1@bloomberg.net.